By Paul Davies, Fiona Maclean and Stuart Davis

Blockchain is more widely recognised as the underlying software technology usedVirtual Currency B - Single for the cryptocurrency Bitcoin. This technology is also being increasingly applied to alternative opportunities, including in the energy sector. In its simplest form, a blockchain is a shared, and continually reconciled, database. No central repository of the database exists and, instead it is hosted simultaneously across a network of computers or nodes. This means that each participant in the network has real-time access to a “golden source” of the data stored on the database without the need for trusted intermediaries and costly data reconciliation. Automated code-based processes called “smart contracts” can run off, interact with and update the database in a way that would not be possible without a golden source of data and real-time reconciliation. In the energy sector, this technology can be used to provide an automated transaction model with no or limited third-party intermediaries (as compared to the traditional transaction model which is multi-tiered, involving a provider, a central authority such as the National Grid and the consumer). Blockchain’s ability to track the flow of electrons on a distributed grid, for example, enables their secure and transparent trade between consumers directly. The advent of blockchain could fundamentally change the way consumers use and generate electricity.

An early adoption of blockchain in this context is TransActive Grid, a peer-to-peer distributed energy offering based in Brooklyn. TransActive Grid, amongst other things, enables consumers to buy and sell renewable energy directly to each other by utilising blockchain technology. Homes producing their own energy through solar power, can sell excess energy to neighbours. Smart meters are used to record the level of energy produced, with transactions being effected and recorded through smart contracts. There are also plans to develop an application for consumers so that any excess electricity can be traded efficiently, with consumers specifying the price they are willing to pay. This has opened up a peer-to-peer market which facilitates direct interaction between consumers and it is hoped that this will develop into a local community market for renewable energy. Grid Singularity, based in Austria, is planning to bring a similar, decentralised electricity market to developing countries, to distribute solar power.

One of the perceived benefits of decentralised systems like the above is that they can better withstand natural disasters, enabling consumers to rely on a local micro-grid when the main system fails. This type of regional self-sufficiency also enables consumers to become more actively involved in the energy sector as suppliers and traders. Due to its synchronised nature (the generation of consumption and ability to record transactions accurately), blockchain would also be the first technology to make it possible to determine the source of electricity. This would simplify the current process of issuing certificates for emission allowances and energy efficiency improvements. Separately, there have been issues with fraud in the EU’s Emissions Trading System (ETS), set up so that such emission allowances can be provided and/or bought at auction or traded. Arguably, blockchain provides greater security. Within each blockchain, data is hashed and stored in a series of blocks thus creating a chain. If any of these blocks are altered, the chain breaks. It is this immutable nature of blockchain which makes it such an appealing technology for recording critical transactions.

As blockchain develops over time, it will increase the number of stakeholders within the energy sector and result in new trading platforms and business models. Regulations must evolve to accommodate these developments. As financial transactions shift from energy companies and banks to a peer-to-peer system, the question arises as to who will be responsible for ensuring such transactions are settled. For example, this would include the enforcement of contractual obligations under supply contracts. Without a central authority in place, clear liability rules must also be established. These should cover payment defaults, technical failures and security risks. Whether these rules should differ according to each local energy market is also another interesting question.

It is also important to highlight the limitations of blockchain. This technology does not resolve the question of how energy is generated, whether it is clean or conventional. In addition, participants will be still be reliant on existing energy networks for the distribution of such energy. How this will be funded, and how investment is secured, will be key issues to resolve if communities trade between themselves rather than with mainstream electricity retailers. Solving data protection and privacy concerns will also be crucial given the public and immutable nature of the distributed database.

The application of blockchain in the energy sector will be fuelled by further technological progress and additional regulatory intervention. For such innovation to go mainstream and reform the wider energy sector, crucial market and technology infrastructure needs to be developed, including user-friendly applications as blockchain shifts production to consumers. As distribution will likely remain reliant on existing energy networks, partnering with central authorities may be the most effective means to deliver substantive value via blockchain.

Read more on blockchain:

Cryptocurrency: A Primer

World-First Regulatory Sandbox Open for Play in the UK

This post was prepared with the assistance of Ei Nge Htut in the London office of Latham & Watkins.